FSA warns on rogue trader risks

The UK's Financial Services Authority (FSA) is calling on City banks to tighten up systems and controls in order to prevent a repeat of the rogue trading scandal at French bank Société Générale.

In its Market Watch newsletter the FSA says it has spoken informally to 50 of the largest trading banks in London and found that many were reviewing systems and identifying and fixing gaps in trading controls following the SocGen case.

The watchdog says it is highlighting the sorts of measures which firms should consider when reviewing the systems and controls which protect them against rogue trader risk.

"The current volatile market circumstances significantly heighten the chances that inappropriate practices could quickly lead to record losses, so early discovery and remedial action are even more important than in 'normal' times," says the FSA.

The watchdog says institutions should ensure that responsibilities and reporting lines are set out clearly in the front office. Firms should also make sure that control and oversight by front office management is "promoted and rewarded" - for example, if it is made known to senior management that a trader has a high number of cancelled and amended trades.

Banks should also consider whether the front office "culture" is designed to prevent 'rogue trader' activities, says the FSA.

Traders should be encouraged or required to take two-week continuous holidays, which would help catch rogue trader activity and be a preventative measure, says the regulator. Firms should also give traders 'desk holidays' where they take a break from marking or valuing their own books and a colleague takes over.

These recommendations follow reports that Jérome Kerviel - the junior trader that allegedly racked up EUR4.9 billion losses at SocGen - only took four days of holiday in 2007. Following a probe into the rogue trading scandal, the French government called on banks to reinforce "Chinese Walls" between the back, middle and front office and to monitor unusual behaviour - such as when a trader does not take holidays.

The FSA's report also calls on banks to consider whether IT security and access controls are properly implemented to ensure that users may only access those functions that their duties require.

Furthermore - following claims by SocGen that Kerviel used loopholes in controls and risk management procedures to conceal fictitious transactions - the FSA says consideration should be given to specific steps that need to be taken in circumstances when people move from the middle or back office to working in the front office - or vice versa.

Institutions also need to make sure elementary IT precautions are in place - such as whether access to systems is password dependent. In the SocGen case, the French bank said last month that it would implement biometric access controls for trading personnel after an internal investigation found major weaknesses in its supervision, security and control procedures.

Sally Dewar, FSA MD of wholesale and institutional markets, says overall the FSA is "encouraged" that firms in London with significant trading activities are working to ensure that basic controls and governance surrounding trading, risk management and settlement are effective.

"But the risks remain, and we would urge firms to remain vigilant on unauthorised trading, especially in current market conditions," she warns.